More on Circuit City and the Value of Risk Management to Prevent Crises

Below a few days ago, I wrote a post about the demise of Circuit City at a time when competitor Best Buy is doing quite well. Not to beat a dead mule, but I want to add to what I wrote before from a risk management perspective.

Circuit City’s per-share earnings trend like this:
FY 2005 -- $.31
FY 2006 -- $.77
FY 2007 -- $.47
FY 2008 – ($1.02)
FY 2009 first 6 months – ($2.45)

What steps did Circuit City take when earnings declined in 2007? The annual report’s letter to shareholders that year said, “We began a process to transform Circuit City two and a half years ago, and we are committed to the vision we laid out to better serve our customers, our Associates and our shareholders…. We also need to ensure that Circuit City has caught up to retail industry best practices with our merchandising and retail transformation efforts. I would characterize these efforts not as a change in plan or strategy, but rather an acceleration of our overall transformation given the rapid changes in our marketplace.” The writer had to chuckle when writing about retail “best” practices.” I love puns!

What did the CEO have to tell shareholders after losing money in 2008? “We are nonetheless disappointed in our financial performance, which was negatively impacted by the disruption created by our necessary and broad-based initiatives…. While the amount of change was disruptive in the short term and contributed significantly to our sales and gross margin declines from the prior year, we are now in the position to improve execution and customer service. As a result, we expect to become a stronger, more effective company during the current fiscal year primarily through an intense focus on retail execution.” That was exactly the right word to use: “execution.” Phillip Schoonover, the CEO who signed these shareholder letters, is no longer with the company.

The new CEO, James Marcum, stated in the second-quarter release on September 29, “The management team and the board of directors are conducting a comprehensive review of all aspects of our business to determine the best methods of delivering substantially improved financial performance and maximizing shareholder value. We recognize that this will require that we intensify our efforts to correct problems in our business.”

Let’s see. The effort to transform Circuit City began in FY2004. After 2007’s drop in earnings, the effort intensified and earnings suffered. Then, after two more losing quarters this year, the company is still intensifying. But the last time it intensified, earnings dropped further. It seems there should have been more new initiatives and less intensification.

I went to Tom Thompson, the Institute for Crisis Management’s risk management wizard (his bio is at http://www.crisisexperts.com/Tom.htm) and asked how Circuit City might have responded differently from a preventive risk management perspective. (Tom was my guest blogger last month. See http://crisisexperts.blogspot.com/search?updated-max=2008-10-11T21%3A32%3A00-04%3A00&max-results=7.) He gave me this explanation:

“The two questions become: Was the crisis truly unexpected or unknown, and what is the true cost of risk? Circuit City’s financial performance provides a clear answer to the first question. The answer to the second question: bankruptcy and perhaps the end of the company. Risk management is by definition the identification and treatment of risk that can impact your business. Risk management is a process. How do you uncover and identify risk and exposures that can impact the intrinsic value of your business?

“Let’s look at risk identification. ICM is different from other firms dealing with crises because we take a holistic approach. We want to identify and treat those exposures and risks before they become crises. The identification process is the first step in risk management.

“1) We start by assuming that risk and exposure are found in each fundamental area of a company: Human Resources, Finance, IT, Operations, Marketing, Legal, etc.

“2) We assert that to begin, you would examine risk by logical classifications: property, human resources, liability, net income, etc.

“3) Tools that are applied include: checklists, flowcharts, physical inspections, financial statements (unfunded liabilities), compliance reviews, contract reviews, policies and procedures reviews, organizational charts, previous loss information, discussions with legal counsel on post litigation, and insurance policy reviews.

“Many crises can be avoided if the risk or exposure is identified and steps are taken to mitigate, reduce, or completely avoid the crisis. Maybe Circuit City performed a risk assessment early during its financial skid, I don’t know. If so, it failed to identify the right steps to mitigate, reduce, or avoid its financial crisis. Effective risk management should have helped soften the blow.”

Thanks, Tom. I guess the moral of this story is to be sure you periodically make a risk assessment of your entire business. That’s truer in this economic environment than ever before. A financial risk management plan may need revisited every month or two these days.